By John A. Moore and The Bankruptcy Department of Powell Goldstein LLP[1]

Trade Creditors

In typical cases, trade creditors simply have an unsecured claim for goods and services they delivered to a debtor prior to the debtor’s bankruptcy filing. However, the Amendments provide new or expanded claims with respect to certain pre-bankruptcy transactions.

New Priority Claim

Under the Amendments, creditors are entitled to an administrative expense claim for “the value of any goods received by the debtor within 20 days before the date of commencement of [the bankruptcy] case . . . in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”[1] Administrative expense claims are accorded a priority status and generally must be paid in full before payments are made to other unsecured creditors.[2]

Expanded Reclamation Rights

Prior to the enactment of the Amendments, the Bankruptcy Code preserved a creditor’s right to demand reclamation of goods delivered to the debtor to the extent the creditor had such rights under applicable state law. Most state laws allow a creditor to reclaim goods upon learning of the debtor’s insolvency if the creditor makes a written reclamation demand within a specified time period, generally within ten (10) days after delivery of the goods to the debtor. Prior to the Amendments, the Bankruptcy Code expanded that 10-day window to 20 days if the tenth day fell on or after the date of the bankruptcy filing.

The Amendments broaden these reclamation rights in two respects. First, they create what is essentially a federal right of reclamation in that the creditor no longer has to establish it has a right of reclamation under state law. Second, the Amendments increase the window of time for reclaiming goods. Specifically, they provide that a creditor can demand reclamation of goods that were delivered to the debtor within forty-five (45) days before the commencement of the case.

Receipt of Bankruptcy Information

Creditors will be pleased to learn that the Amendments contain some practical improvements to the notice requirements that debtors must give creditors. These changes will help minimize two problems frequently encountered by creditors: (1) properly identifying the correct debtor account (sometimes a problem when many affiliated companies file bankruptcy and notices are sent out under the name of a separate, unfamiliar entity), and (2) receiving notices at the correct address of the creditor (sometimes a problem when the only address available to the debtor is a payment address or payment lockbox maintained by the creditor’s bank).

The Amendments provide that any notice required to be delivered to creditors must contain the name and address of the debtor and the last four digits of the debtor’s taxpayer identification number.[3] In addition, the Amendments contain the following provision allowing creditors to specify an account number that debtor’s must reference in their notices to creditors along with an address where the notices should be delivered: If, within the 90 days before the commencement of a voluntary case, a creditor supplies the debtor in at least 2 communications sent to the debtor with the current account number of the debtor and the address at which such creditor requests to receive correspondence then any notice required by this title to be sent by the debtor to such creditor shall be sent to such address and shall include such account number.[4]

In light of the foregoing, creditors may want to modify their invoices to include provisions specifying the account number assigned to the debtor and specifying the address where all written correspondence (other than payments) should be delivered. Notably, the Amendments also provide that failure to provide the correct notice to a creditor can protect the creditor from monetary penalties if the creditor violates the automatic stay (such as by repossessing property in the debtor’s possession) prior to the creditor’s receiving adequate notice of the bankruptcy filing.[5]

Defense to Preference Claims

The bane of many creditors is a debtor’s ability to recover “preference” payments made to the creditor - i.e., payments made by the debtor within 90 days of the bankruptcy filing. The Amendments provide that debtors whose debts are primarily business debts (as opposed to consumer debts) can no longer recover preference payments if the aggregate amount involved is less than $5,000.[6]

In addition, the Amendments expand one of the statutory defenses to preference claims commonly referred to as the “ordinary course of business” defense.[7] To establish that defense, creditors previously had to prove two elements: (i) that the payments were made within the ordinary course of business between the debtor and the creditor and (ii) that they were made according to ordinary business terms. The latter prong was routinely described as the “industry standard” requirement, and creditors had to show the debtor’s payments were ordinary according to industry wide standards.

Now, however, the Amendments provide that the ordinary course defense may be established by proving either of the two prongs. Accordingly, a creditor need not bother with having to prove the industry standard if the challenged payments were made in the ordinary course as between the two parties. Conversely, payments that are outside the ordinary course as between the debtor and the creditor may nonetheless be protected if they were ordinary according to industry standards.

ERISA/Employment

Multiple changes were made to the Bankruptcy Code in the area of labor and employment and ERISA, principally intended to address the perceived abuses of the system by executives in high-profile cases such as Enron and Worldcom, on the one hand, and perceived abuses by consumers on the other.

Automatic Stay

Under section 362 of the Bankruptcy Code, an automatic stay goes into place upon the filing of a bankruptcy petition. However, section 362(b) provides that the filing of a petition does not operate as a stay in certain circumstances. The amendments have added a new section (b)(19) which provides that the stay does not apply to withholding income from a debtor’s wages, and collection of amounts withheld under the debtor’s agreement authorizing that withholding and collection for the benefit of a pension, profit sharing, stock bonus or other plan established under section 401, 403, 408, 408A, 414, 457 or 501(c) of the IRC that is sponsored by the employer of the debtor or an affiliate, successor or predecessor of such employer but only to the extent that the amounts withheld and collected are used solely for payments relating to (i) a loan from a plan under section 408(b)(1) of the ERISA or is subject to section 72(p) of the IRC or (ii) a loan from a thrift savings plan permitted under subchapter III of chapter 84 of Title 5 that satisfies the requires of section 8433(8) of such title. The Amendment clarifies, however, that it is not intended to provide that any loan made under a governmental plan under section 414(d) or a contract or account under section 403(b) of the IRC constitutes a claim or a debt under the Bankruptcy Code.

Property of the Estate

Section 541 of the Bankruptcy Code establishes the “property of the estate”. The amendments now provide that property of the estate does not include any amount withheld by an employer from the wages of employees for payment of contributions to an employee benefit plan that is subject to Title I of ERISA or under an employee benefit plan which is a governmental plan under section 414(d) of the IRC, a deferred compensation plan under section 457 of the IRC, or a tax-deferred annuity under section 403(b) of the IRC. Moreover, any amount withheld by an employer from the wages of employees for payment to a health insurance plan regulated by state law is also not property of the estate.

That means that, upon the employee’s bankruptcy, the amounts withheld are not subject to the bankruptcy. Finally, if the company is the debtor, property of the estate does not include any amount received by an employer from employees for payment as contributions to an employee benefit plan, deferred compensation plan, taxdeferred annuity, or health insurance plan as described above.

Fraudulent Conveyances and Insiders

In keeping with Congress’ intent to crack down on the actions of insiders on the eve of bankruptcy, the amendments amend section 548 of the Bankruptcy Code, which is the fraudulent conveyance section. The amendments now provide that a trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property or any obligation (including any obligation to or for the benefit of an insider under an employment contract) which was made by the debtor within two years before the date of the filing of the petition, if (i) such transfer was made with the actual intent to hinder, delay or defraud its creditors or (ii) the debtor received less than a reasonably equivalent value in exchange for the transfer and either the debtor was insolvent or rendered insolvent as a result of the transfer or the transfer was made to or for the benefit of an insider or incurred such obligation to or for the benefit of an insider under an employment contract and not in the ordinary course of business. The significance of this amendment is that an obligation incurred by a debtor as a result of an employment contract within two years of filing the petition can be a fraudulent conveyance even if the debtor was not insolvent or rendered insolvent as a result of the obligation and even if the transfer was not made with actual intent to hinder, delay or defraud creditors. The primary determining factor here will be whether the obligation was incurred in the ordinary business.

The foregoing are only highlights of the Act. The Act is complex and includes detailed provisions that address these and other issues.

References